Microsoft's Extreme Makeover

I have a confession to make: I've recently discovered the infamous video clips of Microsoft (Nasdaq: MSFT  ) CEO Steve Ballmer sweatily chanting and screaming as he exhorts an audience of thousands to "give it up for me!" It's some of the funniest stuff I've ever seen.

But then I think about it as an investor and come to two conclusions:

  1. The passion that Mr. Softy generates rivals that of its greatest competitors, including Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) .

  2. Passion often breeds dysfunction -- though that's my opinion.

Yesterday, Microsoft took its first steps in admitting it has problems to solve. The top brass reorganized the company from seven business units into three: Platform Products & Services, which will house Windows and MSN; Business, which will control the highly profitable Office franchise and related applications; and Entertainment and Devices, which will include the Xbox game console and software, as well as products for mobile phones and other handheld devices.

It seems that by bringing together related businesses, Microsoft seeks to reduce infighting, increase operational control by top executives, and generally boost efficiency. There's little question that the last is needed. A quick check of Microsoft's key ratios over the past 10 years via Morningstar.com shows that operating margins had declined every fiscal year between 1999 and 2004, partly rebounding during fiscal 2005. Microsoft's 36.6% margin was just above the 35.5% the company achieved in fiscal 1996. If you ask me, that signals room for improvement.

The Fools on our Microsoft discussion board had mixed views of the news. Many appeared to think that the reorg is a little like using adhesive bandages to plug a dam. While I'm inclined to agree that reorgs, in and of themselves, have never revitalized a company, it is good to try to weed out inefficiencies.

In that sense, investors could profit if management is able to find ways to generate higher operating profits. That, of course, will hinge entirely on the effective use of research and development dollars. We won't get a perfect picture of that in future results, but return on equity (ROE) -- which measures how effectively management has allocated stockholders' equity -- might be one way to spot progress (especially since Microsoft is debt-free).

Interestingly, since 2000, ROE has bounced around like a rubber ball, finally recovering to more than 20% for fiscal 2005. If R&D spending remains consistent, and ROE keeps rising, yesterday's reorg will look a lot more like the growth strategy Microsoft has billed it to be. So unless you're overwhelmed by the sight of a sweaty Steve Ballmer, Foolish investors might want to stay tuned.

Further Foolish tech talk:

  • AOL and Microsoft? Big mistake, guys.
  • Microsoft is finally booting up Vista and the new versions of Office.
  • How do you measure the impact of R&D? One Fool has an idea.

Fool contributor Tim Beyers realized in writing this story that he needs to reorganize his office. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile, which is here. The Motley Fool has an ironclad disclosure policy.


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